12 Accounting Terms Every Small Business Owner Should Know
- 1 12 Accounting Terms Every Small Business Owner Should Know
- 1.1 Top 12 accounting terms for small and medium businesses
- 1.2 1. Accounts Receivable and Accounts Payable
- 1.3 2. Assets
- 1.4 3. Balance sheet
- 1.5 4. Break-even point
- 1.6 5. Cash flow
- 1.7 6. Cash conversion cycle
- 1.8 7. Cost of goods sold
- 1.9 8. Credit
- 1.10 9. Spend
- 1.11 10. Liabilities
- 1.12 11. Profit (and how it differs from cash flow)
- 1.13 12. Profit and loss statement
12 Accounting Terms Every Small Business Owner Should Know
Starting and running a business means wearing many hats, some hats you may have never worn before. Perhaps one of the biggest leaps for business owners is into the field of accounting. Some of the biggest challenges small businesses face fall under the finance umbrella: managing accounts receivable, cash flow, paperwork, bookkeeping, payroll, and tax returns. There’s a lot of accounting terms and concepts to know, and if you’re not a financial expert, you might find it difficult.
We are here to help you navigate. In our Accounting Guide series, we’ll highlight some of the key accounting terms and concepts you need to know, how to find and work with an accountant, and to start with this article, a Some key accounting terms you need to know already.
Not all business owners enjoy talking finance. However, understanding the basic terms and concepts (and knowing when and where to seek help in your arms) is crucial to your success. It will also help educate you, so you don’t get confused when you meet your accountant or financial advisor.
Top 12 accounting terms for small and medium businesses
Needless to say, here are some of the top accounting terms every small business owner should know.
1. Accounts Receivable and Accounts Payable
These are probably the first terms you need to understand as a business owner, especially if you want to get paid on time. Accounts receivable is money owed to you (for example, unpaid bills and trade credits both fall into this bucket). Managing your accounts receivable and collection processes is essential to maintaining healthy cash flow.
Accounts payable is the exact opposite; it is the amount of money a business owes. For example, if you were pursuing payment from a customer, you would call their account billing department.
A business asset is an asset that a business owns that can be easily converted to cash. Assets are also used as collateral for business loans. They can be tangible (equipment, accounts receivable, vehicles) or intangible (intellectual property). Assets are shown on the balance sheet. For tax purposes, the cost of a property (excluding real estate assets such as land or buildings) can sometimes be depreciated over time.
An accountant can help you accurately assess your assets, ramify their sale, and understand your tax position.
3. Balance sheet
The balance sheet provides a complete picture of the financial position of your business. It summarizes key financial data (assets, liabilities and equity) at a given point in time. Balance sheets can be used to understand a business’ net worth, current and long-term debt, asset management, and comparative data relating to cash, accounts receivable/payable, capital owner, inventory, earnings, etc.
It may seem like an overwhelming financial statement, but it’s important to understand. Business owners can benefit from an accountant’s help to create and interpret an accounting.
4. Break-even point
Different industries have different margins, but breakeven analysis can help you determine at what point you will reach a positive cash flow and profit making situation – your breakeven point. You broke even if your revenue equals all business expenses or total costs (fixed and variable). This exercise can take time, so don’t rush it. Make sure you’re aware of all the costs your business incurs, everything from payroll to paper clips.
5. Cash flow
According to Wasp Barcode Technologies’ latest Small Business Accounting Report survey, cash flow was one of the top challenges facing US small businesses in 2017. Simply put, cash flow is the movement of money in (through accounts receivable) and out of your business. (through accounts payable). It is a delicately balanced operation that is prone to disruptions due to slow customer payments, unexpected costs, lack of access to capital, etc.
To stay on top of cash flow, it’s essential for your business to develop and maintain cash flow forecasts and cash flow statements. Seek help from your accountant to help you spot the warning signs, develop strategies to mitigate problems, etc.
6. Cash conversion cycle
Knowing your cash conversion cycle is an important part of cash flow management. The cash conversion cycle is the time it takes for a business to sell its inventory, collect its receivables, and pay its bills. In an ideal world, this cycle should be as short as possible so that your money is not tied up in inventory or accounts receivable for too long and is free to invest in assets or activities that contribute to the return. income. Calculating the cash conversion cycle (CCC) is something you should do to aid any cash flow analysis exercise and is a key indicator of how your company is managing its working capital.
7. Cost of goods sold
Cost of goods sold (COGS) or cost of goods sold (COS) is the calculation of all the costs involved in making or selling a product. This is a required part of your business tax return and can reduce your taxable income. Knowing your COGS can also help you determine how to price your products profitably and help you ensure a sustainable profit margin is maintained. It will also help you identify which product lines could be killing your bottom line. Cost of goods sold is reported on your profit and loss statement.
From commercial credit (the net terms you extend to customers), to a line of credit, to your personal and business credit score, to credit cards – accessing and extending credit is an important part of doing business. Educate yourself on why credit is important to your business, the importance of healthy credit, and what your financing options are if you don’t want to mix personal credit with credit own business (many small businesses are closed into a system heavily dependent on personal credit). But it doesn’t have to be.
Expenses are the costs incurred in running your day-to-day business – from rent to marketing, to training to mileage. They can be variable (labor costs, materials, supplies, wages), fixed (rent) and accrual (expenses incurred but not yet billed). Some but not all expenses are tax deductible. The IRS has guidelines on what you can deduct.
Liabilities are the legal or financial liabilities your company takes on, such as loan repayments, credit card debt, accounts payable, taxes owed, wages, etc. on your balance sheet.
11. Profit (and how it differs from cash flow)
When you see that your company has good cash flow, you can quickly assume that your business is profitable, but don’t rush to drink champagne! While your business’s cash flow and profits are closely related, they’re not technically the same thing.
When your company has positive cash flow, it means that your cash inflows exceed cash outflows. Profits are similar: For a company to be profitable, it needs to have more money than it does going out. When you find that you have more accounts receivable than payable, it can be easy to assume that your business is profitable. But that’s not always the case.
Your business can be profitable without positive cash flow — and you can have positive cash flow without making a profit.
Read more about the difference between positive cash flow and profitability here.
12. Profit and loss statement
Finally, we come to the P&L or earnings statement. This accounting term refers to an important financial instrument that provides an overview of your business’s performance over time. A profit and loss statement breaks down the revenue generated and the expenses incurred. It helps you see how profitable your business is and how much cash is left after calculating the loss to grow the business, pay off debt or contribute to your salary as a business owner .
In the next article in this series, we’ll discuss which accounting method is best for your business – the accrual method or the cash method. It’s an important decision that can have a big impact on your taxes, time spent with your admin, and your overall financial picture.
5 Financial Metrics To Consider With Your Accountant